Real Estate Accounting and Auditing

• Chapter 1 - Overview
  • Course Objectives
  • Introduction
• Chapter 2 - An Overview of Real Estate Assets and Transactions
  • Learning Objectives
  • Introduction
  • Definition of Real Estate
  • Unique Characteristics of Real Estate
    • The Need for Financing
    • Negotiations and Complex Transactions
    • Long-Term Investment Cycle
    • Recap
  • Real Estate Markets
    • Characteristics of a Real Estate Market
    • The Laws of Supply and Demand
    • The Role of Government
  • Summary
• Chapter 3 - Accounting for the Acquisition and Development of Real Estate Assets
  • Learning Objectives
  • Introduction
  • Overview of the Accounting Issues
  • Preacquisition: The Accounting Rules
    • Case Study: The North Village Ice Rink
    • Capitalizing, Expensing, and Implementing
    • Watch for These Accounting Problems
    • Questions – North Village Ice Rink: Preacquisition Costs
  • Acquisition Costs: The Accounting Rules
    • Watch for These Accounting Problems
  • Development Costs: The Accounting Rules
    • Case Study: The North Village Ice Rink (Continued)
    • Project Costs
    • Capitalized Interest
    • Other Development Costs
    • Selling Costs
    • Questions – North Village Ice Rink: Acquisition and Development Costs
  • Projects under Development: Assessing Possible Impairment
    • Events or Changes in Circumstances That May Indicate Impairment
    • Recognition of Impairment
    • Other Issues: Abandonments and Changes in Use
    • Watch for These Problems
  • Allocating Capitalized Costs
    • Three Steps
    • Project Budgets
    • Methods of Allocating Costs
    • Allocating the Costs of Amenities
    • Watch for These Problems
    • Questions – Cost Allocations
  • Summary
• Chapter 4 - Accounting for Rental Operations
  • Learning Objectives
  • Introduction
  • The End of the Real Estate Development Period
  • Rental Costs
    • Initial Direct Costs
    • Other Rental Costs
    • Amortization Period
  • Accounting for Rental Income
    • Rent Escalations
  • Accounting for Lease Incentives
  • Contingent Rentals
  • Accounting for Lease Modifications
  • Expense Reimbursements
  • Financial Statement Presentation and Disclosure
  • Summary
  • Question
    • Required
• Chapter 5 - Accounting for Investments in Real Estate Ventures
  • Learning Objectives
  • Introduction
  • Pop Quiz – Accounting for Investments
    • Solution to Pop Quiz
  • Types of Ventures and How to Account for Them
    • Forms of Real Estate Ventures
    • Determining Which Accounting Method to Use
    • When Is the Investor’s Interest Minor?
  • Special Considerations When Applying the Equity Method to Real Estate Ventures
    • Allocating Profits and Losses
    • Losses in Excess of the Amount Invested
    • Impairment Losses
  • Accounting for Transactions with a Real Estate Venture
    • Capital Contributions
    • Loans and Advances to a Venture
    • Capitalized Interest on Investments in Real Estate Ventures
    • Accounting for Interest Income on Loans to a Real Estate Venture
    • Providing Services to a Venture
  • Off-Balance-Sheet Financing
    • Synthetic Leases
  • Summary
  • Questions
• Chapter 6 - Accounting for the Impairment of Completed Real Estate Projects
  • Learning Objectives
  • Introduction
  • Overview of FASB ASC 360-10-35 (FASB Statement No. 144)
    • Classification of the Project
    • Determining Whether a Project Is Held for Use or Held for Disposal
    • Changes to a Plan of Sale
    • Summary of the Guidance in FASB ASC 360 related to Impairments (Statement No. 144)
  • Completed Projects Held for Use or Investment
    • Events or Changes in Circumstances That May Indicate Impairment
    • Estimating Expected Future Cash Flows
    • Estimating Fair Value
    • Impairment of Completed Projects Held for Use: Other Considerations
  • Completed Projects to Be Disposed of By Sale
    • Costs to Sell
  • Summary
  • Questions
    • Required
• Chapter 7 - Accounting for the Sale of Real Estate Assets
  • Learning Objectives
  • Introduction
  • Substance Over Form
  • The Two Basic Principles of FASB ASC 360-20 (FASB Statement No. 66)
  • The Four Criteria of FASB ASC 360-20 (FASB Statement No. 66)
  • Part I
    • Full Accrual Profit Recognition – Accounting for Sales That Do Not Involve Seller Financing
    • Accounting for Sales Involving Seller Financing
    • Exercise 7-1: Sale of a Mobile Home Park
    • Solution to Exercise 7-1: Sale of a Mobile Home Park
    • Recap
    • Questions – Part I: Full Accrual Profit Recognition
  • Part II
    • Accounting for Transactions That Do Not Qualify for Full Accrual Profit Recognition
    • Questions – Part II: Sales of Real Estate
  • Summary
  • Appendix 7A – Accounting for Continuing Involvement FASB ASC 360-20-40, Paragraphs 37-64
    • Continuing Involvement without Transfer of Risks and Rewards
    • Seller Option or Obligation to Repurchase
    • Seller Is General Partner in Acquiring Limited Partnership
    • Seller Guarantees
    • Seller Supports Operations
    • Buyer Option to Purchase Property
    • Partial Sale by Seller
    • Sale of Condominium Units
    • Seller Sells Property Improvements and Leases the Underlying Land to the Buyer of the Improvements
    • Sale of Property with Leaseback to Seller for All or Part of Its Remaining Economic Life
    • Future Development Required by Seller
    • Seller Participation in Future Profit from the Property without Risk of Loss
  • Appendix 7B – Methods Other Than Full Accrual Profit Recognition, FASB ASC 360-20-55, Paragraphs 6-17
    • Methods of Accounting for Real Estate Sales when Criteria for Full Accrual Method Are Not Met
    • Installment Method
    • Cost Recovery Method
    • Reduced-Profit Method
    • Deposit Method
• Chapter 8 - Accounting for Sale-Leasebacks and Nonmonetary Exchanges
  • Learning Objectives
  • Introduction
  • Sale-Leaseback Transactions
    • Substance over Form Issues
    • A Description of Sale-Leaseback Accounting
    • Determining Whether a Transaction Qualifies for Sale-Leaseback Accounting
    • Recognizing Profit or Loss
    • Questions – Sale-Leaseback Transactions
  • Nonmonetary Exchanges
    • Nonmonetary Transactions That Do Not Have Commercial Substance
    • Question – Nonmonetary Exchanges
  • Summary
    • Sale-Leaseback Transactions
    • Nonmonetary Exchange
  • Appendix – Excerpts from FASB ASC 840-40-55 (FASB Statement No. 28)
    • Example 6: Leaseback of Real Estate that Is Minor
    • Example 7: Leaseback that Is Not Minor but Does Not Cover Substantially All of the Use of the Property
    • Example 8: Leaseback that Is Not Minor but Does Not Cover Substantially All of the Use of the Property
• Chapter 9 - Planning the Audit of a Real Estate Entity’s Financial Statements
  • Learning Objectives
  • Introduction
  • Professional Skepticism
  • Understanding the Client and the Industry in Which It Operates
    • The Audit Risk Alert
    • Other Sources
    • Knowledge of the Client
    • Where to Go for Information about the Client
  • Introduction to the Risk Assessment Standards
  • Risk Assessment
    • Related-Party Transactions
  • Analytical Procedures
  • Internal Control Considerations
    • Overview of SAS No. 109 and SAS No. 110
    • Applying SAS No. 109 and SAS No. 110 to Audits of Real Estate Entities
    • Communicating Internal Control Related Matters under SAS No. 115
    • Communication with Those Charged with Governance under SAS No. 114
  • Considering the Possibility of Fraud
    • Auditor's Response
    • Frauds Common to Real Estate
  • Planning Substantive Tests
  • Going Concern Considerations
  • Client Representations
  • Summary
  • Questions
    • Required
• Chapter 10 - Auditing Real Estate Transactions
  • Learning Objectives
  • Introduction
  • A Quick Review of Audit Theory
  • Cost Capitalization and Allocation
    • Overall Audit Objectives and Planning Considerations
    • Watch for These Things
  • Rental Income
    • Overall Audit Objectives and Planning Considerations
    • Watch for These Things
  • Valuation and Impairment
    • Overall Audit Objectives and Planning Considerations
    • Watch for These Things
  • Sales of Real Estate
    • Overall Audit Objectives and Planning Considerations
    • Watch for These Things
  • Summary
  • Questions
  • Appendix – Audit Programs
    • Audit Program Steps: Cost Capitalization
    • Audit Program Steps: Rental Income
    • Audit Program Steps: Valuation and Impairment
• Chapter 11 - Techniques for Estimating Fair Value of Real Estate Assets
  • Learning Objectives
  • Introduction
  • Real Estate Appraisers
  • Market Value vs. Fair Value
    • Fair Value
    • Market Value
  • Date of the Appraisal
  • The Real Estate Appraisal Process
  • The Cost Approach
  • Market Data or Comparable Sales Approach
  • Direct Capitalization Approach
    • Calculating NOI
    • What Is the Capitalization Rate and How Is It Determined
    • Applying the Direct Capitalization Approach
  • Discounted Cash Flow
    • Determining the Discount and Terminal Capitalization Rate
  • Other Considerations
  • Summary
  • Questions
• Chapter 12 - Latest Developments
• Appendix A - AICPA Audit and Accounting Guide – Guide for the Use of Real Estate Appraisal Information
• Appendix B - Statement on Standards for Valuation Services No. 1

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Real Estate Markets

Economists describe a real estate market as one of “monopolistic competition” because it combines elements of a monopoly with those of a purely competitive market. In a purely competitive market the goods are relatively homogeneous, divisible into small groups, and easily transportable. Barriers to entering the market are low. Many buyers and sellers exist, with no single one able to influence price.

Each market participant has complete knowledge about the product and is in general agreement about expectations about how the product will perform.

Characteristics of a Real Estate Market

Real estate markets do not have all of the characteristics of a purely competitive market. For example,

• A real estate asset is generally unique.

• Real estate assets occupy a fixed space and cannot be transported.

• Large owners or buyers have the ability to affect market price.

• Buyers and sellers of real estate often differ in their expectations of how the asset will perform or be used.

Although a given real estate asset enjoys certain monopolistic advantages (for example, location), similar assets offer close, though not perfect, substitutes. A premium will be paid for the monopolistic advantage, but only to the extent of the advantage perceived by the buyer.

The Laws of Supply and Demand

Within a given market, the prices of real estate assets are influenced by supply and demand. Of course, as with other markets, there is interdependence between the supply of real estate and the demand for real estate. When supply is greater than demand, development slows until the excess is absorbed and vice versa.

It is a bit of a “chicken and egg” problem to distinguish between a factor that drives supply and one that drives demand, but the following analysis should at least help you understand some of the supply and demand considerations.

Demand Factors

Factors that affect the demand for real estate include

• Mortgage interest rates.

• General economic conditions.

• Demographic changes and societal trends.

Mortgage Interest Rates

Because of the size of the debt financing for most real estate acquisitions, the level of mortgage interest rates affects the affordability of real estate assets. When interest rates fall, real estate becomes more affordable, and more buyers are encouraged to enter the market.

General Economic Conditions

General economic conditions affect businesses and their need for space. During expansionary times, if businesses grow, their need for office or warehouse space also will grow. Conversely, during a general recession, if businesses shrink, their need for space also will shrink. General economic conditions also impact wages and levels of individual income, which in turn affect the demand for housing. Mere perceptions of general economic conditions also can affect the demand for real estate. For example, perceptions among homeowners that the economy is strong or improving may lead to increased demand for housing.

Demographic Changes and Societal Trends

Trends toward corporate downsizing or telecommuting may affect the need for commercial space. The twentieth-century shift of the U.S. population from rural to urban to suburban altered the demand for housing in locations affected by the shift. The shift of the population in the early part of the 21st century will also impact real estate.

Supply Factors

Factors that affect the supply of real estate include

• Cost and availability of financing.

• Expected future demand.

• Changes in public policy.

Cost and Availability of Financing

When financing is not available or is available only at a high cost, real estate development will slow. As pointed out earlier, the converse also is true.

Expected Future Demand

When developers anticipate future demand for a product, they will develop that product. When they are pessimistic about future demand, they will decrease their level of development activities.

Changes in Public Policy

As described below, the federal, state, and local governments each play a significant role in the real estate industry. Changes in public policy (for example, changes in zoning or building codes) may affect the supply of real estate projects.

The Role of Government

Federal, state, and local governments each play an important role in the real estate industry and market. Governmental factors affecting real estate include

• Tax laws.

• Property taxes.

• Zoning.

• Building codes.

• Department of Housing and Urban Development (HUD) laws.

• Environmental regulations.

Tax Laws

Tax laws are one means used to implement public policy regarding the investment in or development of real estate. For example, tax law changes have been used to expand or contract the flow of funds to the industry.

The use of tax-advantaged entities (for example, real estate investment trusts, or REITs) is common in the real estate industry. The continued qualification of these entities for special tax treatment is a significant concern that should be addressed by auditors.

Property Taxes

The federal government is prohibited by the Constitution from levying a property tax; property tax is levied at the local level. The amount of the tax is calculated as a percentage of the property's value.

Zoning

The local government is responsible for zoning, which involves designating areas for various types of land use. Within a given zone, regulations might restrict property usage, such as the ways in which a building might be used, the percentage of land allowed to be covered by buildings, or the maximum height of a building. Zoning will impact development.

Building Codes

Building codes regulate the development and construction to help ensure safety, facilitate fire prevention, and provide adequate sanitation. For example, the thickness and height of walls and spacing of beams usually are regulated, as are the plumbing, electrical, and ventilation specifications. Cost of development may be affected by building code requirements.

Department of Housing and Urban Development (HUD) Laws

HUD is a federal agency that regulates the development and operation of all housing projects for which it insures mortgages or provides rent subsidies. These regulations include the requirement that audits of these entities be performed in accordance with the Consolidated Audit Guide for HUD Programs (issued by the HUD Office of the Inspector General), generally accepted auditing standards (GAAS), and Government Auditing Standards.

Environmental Regulations

Environmental regulations, like laws granting protection to wetlands, limit the available uses for designated parcels of land. Environmental remediation laws impose significant liabilities on those responsible for cleaning up contaminated property, and the presence of environmental contamination affects an entity's ability to sell its property.

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